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More On Missing The 10 Best Days

posted on August 27, 2007

Blogger Nickel at fivecentnickel.com made some great comments to my post about missing the 10 best days in the stock market. I showed in my post that the probability of missing the best 10 days in 10 years is one in 2.8 billion billion billion. Nickel disagreed. Because the comments require a long response, I’m making a new post as opposed to burying it in the comments. First, the comments from Nickel:

“While you’re correct that this overstates the problem in that people won’t miss just the 10 best days of the market, you’re forgetting that the biggest days often come in the earliest stages of a recovery.

“For example, looking over the past 25 years, three of the 10 biggest days came in the week and a half following Black Monday, and two more of them occur in close succession at the very tail end of the dot bomb debacle. Thus, these days are concentrated into periods when people are especially likely to have bailed on the market and not gotten back in.

“Consider the scenario in which sometimes gets smacked on Black Monday, jumps out of the market to lick their wounds, and then immediately misses gains of 9.3%, 5.3% and 4.9%. They’ve now locked in a huge loss that they had little chance of avoiding in the first place, and they also missed out on a huge recovery.

“Calculating the probability that people will randomly miss the ten best days is a *huge* oversimplification, and it casts doubt on your entire argument.”

I want to thank Nickel for the comments and address the issue of best days coming right after the stock market bottom. Since he brought up Black Monday in 1987 and the dot com bubble, let’s take a closer look.

Black Monday was October 19, 1987. The S&P 500 dropped a whopping 20.5% on a single day, from 282.70 to 224.84. Let’s say a nervous investor sold the very next day on the open. The price was 225.06, close to the bottom made on the previous day. In the next 10 days, he would’ve missed 3 of the 10 best days in the next 20 years, which had returns of +5.33%, +9.10%, and +4.93% respectively. Does it mean this investor missed a total of (1 + 5.33%) * (1 + 9.10%) * (1 + 4.93%) – 1 = 20.6% of returns? No, after 3 best days passed, S&P 500 closed at 244.77 on 10/29/1987, up 8.8%, not 20.6%, from the 225.06 level he sold at. A little over a month later, on 12/3/1987, the market returned to 225.21, which was about the same level as the previous bottom. Now, having missed 3 of the 10 best days in the next 20 years, this investor didn’t suffer any damage if he got back in a month and half later.

Date

S&P 500 Close

10/16/1987

282.70

10/19/1987

224.84 (sold here)

10/20/1987

236.83

10/21/1987

258.38

10/29/1987

244.77 (missed 8.8% of gains)

12/03/1987

225.21 (back to where it was)

Now, let’s look at the same for the 2 best days in 2002. On 7/24/2002 and 7/29/2002, the S&P 500 had two best days, up 5.73% and 5.41% respectively. By then the bear market had gone on for over two years. If an investor was nervous, he would’ve sold way before then, perhaps in early 2001 when the S&P 500 dropped to 1,300 from 1,500 in the previous year, or in early 2002 when the S&P 500 dropped more than 20% in two years. For argument’s sake, let’s say our unlucky investor sold right before the best days, on 7/23/2002, at the close of 797.70. After two of the 10 best days in 25 years, the market closed on 7/29/2002 at 898.96, up by 12.7%. Was that a permanent loss of opportunity if the investor missed those two best days? Once again, no. 2 months and 10 days later, on 10/7/2002, the S&P 500 went back to 785.28, lower than the 797.70 price before the best days.

Date

S&P 500 Close

1/3/2000

1,455.22

1/2/2001

1,283.27 (down 12% from a year ago)

1/2/2002

1,154.67 (down 21% from two years ago)

7/23/2002

797.70 (sold here)

7/24/2002

843.43

7/29/2002

898.96 (missed 12.7% of gains)

10/7/2002

785.28 (lower than where it was)

Will the market always return to the previous low before the best days? I don’t think anybody has an answer to that. The market is volatile and unpredictable. I continue to believe that (a) it’s impossible to miss only the 10 best days; and (b) even if some best days were missed, the damage isn’t nearly as bad as those meaningless stats imply.

Suppose calculating random odds is a *huge* oversimplification like Nickel said, and because the best days often come in the early recovery days, I’m off by a factor of a billion. That is huge, right? Say instead of one in 2.8 billion billion billion, the odds of missing the 10 best days in 10 years is actually only one in 2.8 billion billion. That is still 100 times less likely than winning 2 consecutive Powerball jackpots with the same set of numbers. If I write about what I would do if I won 2 consecutive Powerball jackpots with the same numbers, nobody will take me seriously because it’s meaningless to talk about impossible events. Well the stats on missing the 10 best days in 10 years fall into the same camp. They are not worth the attention given to them.

Trust me, I don’t advocate timing the market. I just think this missing the 10 best days in 10 years thing is over-hyped by at least a factor of a billion. My question to Nickel and all other readers, if it’s not one in 2.8 billion billion billion, or one in 2.8 billion billion, what do you think the odds are for missing the 10 best days in 10 years and how do you prove it?

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If the market timing strategy is to anticipate the 10 worst days and get out right before them, then yes, this analysis shows that it won’t work. It also shows that missing the 10 best days is not a reason not to time the market. I hope you can tell the subtle difference here.

Missing the 10 best days is a bad example. It’s not going to happen. Let’s just not use it. If we say the best days are so easy to miss because they usually happen after a selloff, market timers can come back with another strategy: stay out of the market until a big selloff, then pile on. If we say this strategy won’t work, we must also admit missing the 10 best days won’t happen either.

Market timing takes many shapes and forms. I don’t think we can positively prove they ALL won’t work. A market timing strategy doesn’t have to work all the time. It only has to work during the life time of those who practice it. I don’t think there is a way to identify which strategy will work at what time, but I have no proof.

I too am not an advocate of market timing, however, many fundamental investors will sit on large amounts of cash when bottom up analysis dictates that the values are not there in the market (i.e. stock prices are too high).

These investors do so in the face of these kinds of stats on missing the best days of the market over say 10 years.

Thus, I see TFB’s argument as one which should embolden such fundamental investors fraught over “missing something” when in fact they are prudently protecting investors capital.

I got out the day Lehman went under and Merrill was about to follow, albeit in a different fashion. Sold every nickel I had in stocks except for a small stash in 2 volatile funds that had already gone done a ton so nothing to do but wait for the uptick. Had a huge chunk in an S&P 500 index and got out of that at 110.

I’d never been a market timer and never been ‘out’ of the stock market a single day since the late 80s, but seeing the crap happening that day brought to mind the old quote about “I’m no longer worried about the return ON my money; I’m now worried about the return OF my money”. Well, that was me, folks. I’ve got mortgages on 2 homes and another on a commercial investment, have a nice job but nonetheless one that could go up in smoke tomorrow if a buyout occurred and it was time to get defensive.

A week ago after the multi-nation action to stem the bloodletting, the market rallied a ton up from about 83 all the way to about 92 and a couple of buddies enjoyed sending me the news (like I hadn’t already seen it). I responded that this crazy market isn’t cured and the euphoria likely wouldn’t last and I’m staying put. It didn’t stay, it went way down again to about the exact same level, and I’m still staying put. There have been a couple of good days (which I don’t mind at all, frankly) but here we are aboug a month after I got out and the index is at 90. So I’ve saved 6 figures by getting out at 110, missed some GREAT days in the market, and if I got fully back in today I’d be up over 18%.

I completely agree with the negative effects of long term market timing, but I’m also living proof that if you see a freight train coming, it’s better to get out of the way than recite the incredibly low statistics about how many people get hit by freight trains each year. I’ll start putting some of the money back in shortly and dollar cost averaging my way back to my former investment levels. That said, I expect a LOT more volatility in the coming year and wouldn’t be surprised to see a huge spike down if Obama gets elected due to his Cap Gains stance. But I don’t want to be completely out if McCain pulls a rabbit out of his hat and the market rallies. I know, it sounds like gambling rather than responsible investing but right now I’ve got 18+% of the house’s money – so I’m rolling with it.

The premise of missing the ten best or the worst is based on a notion of clairvoyance that you could miss just THOSE days. This idea is based on market timing as predictive. To that point, it is a fool’s errand. This “missing the ten best” myth has been perpetuated by an industry that is only paid if you stay invested. Wall Street has not figured out how to get paid for sitting in cash.
If you review many of the studies, you do find that many of the “best” days are recovery days following some of the “worst” days. If you were not invested in the worst days you would not need the best days to earn back what you lost. Losses hurt a portfolio worse than gains because losses and gains do not have a linear relationship. Remember that a 50% loss requires a 100% gain to get back to par. I use two trend following models published in the mid 90’s that got you out of the markets in early 2000 and in late 2007. The models did not get you back into the markets until mid 2003 and am still on the sidelines now. Having avoided both 50% bear markets, you do not have to rush to get back in to earn what you have lost. If you want to continue to listen to Wall Street you will continue to be dumb money.

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